Hedge funds fell out of favour in the years after the 2008 global financial crisis, as fund managers struggled to deliver sufficient alpha to justify their fees, during a period of low interest rates and sustained gains in the S&P 500.
Hedge funds have been in decline for more than a decade. According to data from Tiger 21, a network of ultra-high-net-worth investors and entrepreneurs, hedge fund allocations fell from 16 per cent in 2008 to 2 per cent in the first quarter of 2025 (up one percentage point from Q1). The group’s members favoured alternatives that offered lower fees and/or better performance overall, such as index funds or private equity investments.
But there have been green shoots of recovery as economic and geopolitical factors shift once again. Last year, the Wall Street Journal described 2024 as ‘the year that hedge funds got their mojo back’, as the average hedge fund posted a double-digit return, beating a typical 60/40 portfolio split between stocks and bonds. In recent years, traditional macro ‘anchors’ such as stable inflation, predictable fiscal policy and global cooperation have all been weakened, creating an environment better suited to more agile hedge funds – at least according to the latest analysis from BlackRock.
At the start of 2024, BlackRock published a paper arguing that active management would become more appealing in an environment the firm saw developing. Building on their 2024 findings, new BlackRock data, presented in a paper called ‘More Room For Hedge Funds’, suggests things have played out as they expected, with skilled managers generating more alpha in the current investment environment.
As a result, BlackRock has broadened the focus of its analysis to include hedge funds more explicitly. Vivek Paul, global head of portfolio research, BlackRock Investment Institute and co-author of the paper, tells Spear’s investors can hold up to 5 percentage points more in hedge funds today than they did before 2020.
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Here, Paul sets out why.
Loss of long-term macro anchors
Where once investors could rely on stable inflation, predictable fiscal policies and a broadly cooperative geopolitical backdrop, stability kept volatility low; the environment today is very different, Paul explains.
Before the pandemic, markets experienced relatively low volatility, and both stocks and bonds delivered strong returns. As a result, investors had less need to depend on hedge funds or other active strategies. Today’s market conditions are different: relying solely on broad, static asset class exposure is less effective. This environment enhances the appeal of hedge funds, since top-performing managers in certain strategies have greater opportunities to generate alpha.
The current global economy is defined by the loss of long-term macro anchors, such as stable growth, contained inflation expectations and fiscal discipline, that had previously underpinned long-term asset allocation for decades.
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In the absence of these stabilising influences, volatility has risen. Markets are now reacting more sharply to every piece of economic news, whether it turns out to be important or not, explains Paul. This greater volatility, in turn, has led to greater dispersion, with some investments doing far better than others.
Hedge funds, prized for their agility, are well positioned in the current environment, where managing macroeconomic risks has become increasingly important, BlackRock argues.
Key tool in a diversified portfolio
Hedge funds are emerging as a key tool in portfolio construction, BlackRock says, with ‘more opportunity for security selection that can outperform markets – a potentially differentiated source of return in portfolios – rewarding those who deliberately minimise macro risk to favour security-specific risk instead.’
But Paul emphasises the importance of understanding client-specific constraints and objectives when allocating to hedge funds and private markets.
‘A pension fund is solving a very different problem to a sovereign wealth fund or an insurer, so you can’t make an absolute claim because the risk preferences, the tolerance for fees and the governance constraints are different for every type of investor,’ he says.
Don’t group hedge funds with ‘other alternatives’
Paul cautions against treating hedge funds as interchangeable with private markets or ‘alternatives’, a label BlackRock considers ‘an artificial category’. Increasing hedge fund exposure, Paul argues, does not mean investors must reduce allocations to private assets.
‘For a medium-risk portfolio, we typically allocate around 20 per cent to private markets,’ he tells Spear’s, adding that hedge funds and private markets, while both sitting outside public equity and debt, are distinct asset classes with different roles, risks and constraints.
He stresses that adding hedge funds should not automatically come at the expense of private assets, so that the recommended ‘up to 5 percent’ would be on top of the 20 per cent allocation to private markets.
‘For us, the label “alternatives” is an artificial category. When constructing portfolios, you need to consider liquidity, governance, and risk constraints. Those are what should determine your allocation limits to private markets and hedge funds, not a catch-all label,’ Paul says.
Less volatility than equities
When looking at a diversified portfolio that includes different asset classes such as stocks, bonds, hedge funds and real estate, the expected volatility from including macro hedge fund strategies is lower than the risk that comes from including developed market stocks, BlackRock’s data shows.
Macro hedge funds invest across currencies, interest rates, bonds, commodities, and equities. Because their returns don’t move in the same direction as stock markets, their different behaviour reduces overall risk.
‘We find the risk of future returns from certain macro hedge fund strategies is lower than that for developed market public equities in a multi-asset portfolio,’ the authors of More Room For Hedge Funds argue.
More alpha, same skill
BlackRock’s data, Paul explains to Spear’s, shows that top-performing active managers capable of managing or harnessing that macro risk are better rewarded today.
BlackRock’s data illustrates that the new environment has given an opportunity for skilled managers to outperform the market (‘generate alpha’). Right now, the gap between good managers and average ones is bigger than before, says Paul and he expects it to keep widening in the future. Therefore, if you can identify those good managers, there’s more potential reward than in the past.
The investment firm defines these top-tier managers as those whose performance lands in the top 25 per cent among US alpha-seeking portfolio managers. Top-performing US equity portfolio managers have delivered more alpha since 2020, but the average manager has not become more skilful, that is, the excess returns for the average manager haven’t changed.
The question is how investors should take advantage of this opportunity.
‘The main takeaway from this is: find a skilled manager that works for you, understands your client-specific constraints and objectives’, Paul says.
In the current environment, funds that stick to a fixed investment approach are losing out, while those that adjust strategy to take advantage of parts of the market that are performing well are winning, Paul says. ‘And this is not a hypothesis. This is just observed data,’ he says.
A structural shift
Paul believes this new regime is not a short-term call for the next few months, but a structural shift away from the low-volatility ‘Great Moderation’ period that shaped markets from the 1990s.
That means portfolios should be built differently, with greater emphasis on skill and adaptability. Hedge funds, for those able to identify the right managers, are one way to harness that, he says.
